Weapons of Mass Inflation

"...Dark secrets known only to top-level officials; the public good trumping
public disclosure; urgent action needed to avert disaster - haven't we been
here before...?"

IN THE EMERGING economies of East Asia, governments face fresh rioting
if food prices keep soaring.

Here in the rich West, politicians fear a 1930s-style depression if consumers
stop borrowing as home prices sink.

In sum, says the head of the International Monetary Fund (IMF), the world
is caught between "ice and fire". But does mean central banks must keep serving
Baked Alaska for pudding?

The dilemma facing Western policy-makers looks stark enough. Monetize the
credit bubble - by printing money to bail out the banks - and the cost of living
will soar as the value of money evaporates. Or they can let the bubble slip
into default, dragging the banks into bankruptcy, and destroying money itself
in a new Great Deflation.

"By swapping [UK] gilts rather than cash for [Residential Mortgage-Backed
Securities], the Bank ensures that there is no direct effect on the stock of
base money," notes Willem Buiter, a professor at the London School of Economics,
in his blog for the Financial Times.

But "of course, the banks - who now find themselves with excess gilts - will
sell them, either to other private parties who have pockets of excessive liquidity
[meaning cash] or, more likely, to the Bank of England."

Here at BullionVault, we can't
help but imagine Monty Python running this skit. First Michael Palin opens
one teller's window - and swaps T-bonds for junk - before dashing to another
to swap the new bonds for cash.

He could keep shouting "No cash for junk here, sir!" in an angry voice too,
with all the inevitably hilarious consequences.

"Why do the cash for RBMS swap in two stages?" demands Buiter, a former Bank
of England policy-maker. "Why make things simple when they can be difficult,
transparent when they can be made obscure?"

There's a straightforward answer, of course; obscurity works to confuse the
public. The Bank of England's new Special Liquidity Scheme - just like the
Fed's Term-Auction and Term Securities Lending facilities - keeps the whole
sorry sage safely buried in the pink pages.

Just swapping cash for junk, on the other hand, would be simple enough to
make front-page news. But there in the headlines instead, shlock-horror wins
out. Which suits both government and the investment banks fine.

"There is a 'growing case' for government intervention in the US housing market
to arrest the deterioration of global financial markets and slowing economic
growth," according to the British press.

"Given the magnitude of the systemic and macro-economic risks the US faces,
there is a growing case for a finely calibrated public intervention, perhaps
addressing both the demand-side as well as the supply-side of the problem," according
to the Institute of International Finance.

Indeed, this is "the largest financial shock since the Great Depression" claims
the International Monetary Fund. Which in turn props the door open for government
rescues - and government meddling, of course. "The credit crisis has made the
idea of cross-border supervision of the banking industry more palatable," according
to the daily note from SIFMA, the US securities institute.

Says who? Says Charlie McCreevy, commissioner for internal markets and services
at the European Union.

"The present crisis has really sharpened minds of European members about how
we would handle a cross border financial crisis," McCreevy told reporters in
Brussels. And no doubt Bear Stearns stood on one side of many cross-border
derivative deals. So many, in fact, the Fed went to the "very limit" of its
powers - as former chairman Paul Volcker puts it - because the option of letting
Bear fail was simply too scary to contemplate.

"I do not know whether the risks justified the decisions not only to act as
lender of last resort to [Bear Stearns] but to take credit risk on the Fed's
books," wrote Martin Wolf in the Financial Times recently.

"But the officials involved are serious people. They must have had reasons
for their decisions."

Hmmm, sounds familiar, no? Dark secrets known only by top-level officials;
the public good trumping public disclosure; urgent action needed to avert global
disaster.

Haven't we heard this line before? Right around...ummm...five years ago, in
fact?

"My colleagues," announced Colin Powell - then US secretary of state - to
the United Nations on 5 Feb. 2003, "every statement I make today is backed
up by sources, solid sources. These are not assertions. What we're giving you
are facts and conclusions based on solid intelligence."

As it turns out, Powell's "solid facts" came from one single source, an Iraqi
defector known only as "Curveball", during interviews with the BND, the German
intelligence service. Uncorroborated and in fact wholly false, his assertions
found their way this week into a parliamentary hearing in Berlin. The Bundestag's
Supervisory Committee is asking how-in-the-hell a man deemed "unreliable" by
the British intelligence service wound up as sole justification of the US-UK
invasion.

"Elements of his behavior strike us as typical of fabricators," said MI6 in
its assessment. "In truth, he was a sex-obsessed alcoholic," screams the London
press now. But no matter.

"The Prime Minister [Tony Blair] has made the case for the need to deal with
Saddam for some years with consistency," as the left-wing Observer newspaper
claimed ahead of the March 2003 invasion. "Accused of becoming America's poodle,
Blair, in fact, sticks to a potentially unpopular course because he believes
this to be right, and that the threat from Iraqi weapons is real."

Back here in April '08, we'd rather not say whether Blair, Bush and Powell
actually knew their "facts" to be false. Similarly, no one can guess at the
trouble if Bear Stearns collapsed.

But you might want to consider the mischief caused to your pocket by bailing
it out.

"Many parts of America, long considered the breadbasket of the world, are
now confronting a once unthinkable phenomenon," writes Josh Gerstein in the New
York Sun: "Food rationing."

Okay, this is The Sun. But Gerstein points to per-customer-limits imposed
by the Costco chain on rice in Mountain View, California. It's put customer-caps
on oil and flour sales in Queens, New York.

"Due to the limited availability of rice, we are limiting rice purchases based
on your prior purchasing history," read a sign when Gerstein found the chain's "largely
Asian immigrant clientele" in Mountain View grumbling about the new limits.

Store manager Stephanie Gordon then told CBS News that in 21 years with the
company, she's never "seen it like this before." Indeed, "we're actually starting
to see shortages here in the US," confirmed Scott Faber of the Grocery Manufacturers
Association on Monday's Early Show.

Then on Wednesday, Wal-Mart said it's rationing rice sales at its Sam's Club
chain of wholesalers.

How ever did we get here? Shortages on US shelves make for great headlines
of course. They also make it easy to blame third-world food riots and protests
on a shortage of supply as well.

But "there is food on the counters and on the shelves in stores," said Paul
Risley, a spokesman for the UN's World Food Program this week. The problem
in Asia, instead, is that at these soaring prices, "there is a certain population
that cannot afford that food."

"Supply is not the main constraint, but the huge price increases are," confirms
Rajat Nag, head of Asian Development Bank. "That has a very massive impact
on the poor and we need to focus on the huge price increases."

Back here in the West, "the Fed has lots of firepower left" says Greg Ip in
the Wall Street Journal - almost like he asked to Ben Bernanke himself!
In the developing world, in contrast, a "silent famine" now looms.

Two different problems with two separate causes? After the world's greatest
bubble in money - with the greatest cash bail-out to follow - somehow it seems
unlikely.

Formerly City correspondent for The Daily Reckoning in London and head of
editorial at the UK's leading financial advisory for private investors, Adrian
Ash is the head of research at BullionVault,
where you can buy gold
today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

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